The Fed should focus on monetary policy and on the setting of standards for minimum capital and liquidity in financial institutions. It should monitor risks broadly in the financial system, and should participate in examinations of financial institutions, to vary prudential standards as warranted, and to ensure its unfiltered access to information. That new "macro prudential" role for the Fed makes sense, has broad support in the academic community, and could be implemented with reasonable accuracy, according to research showing that such real time policy reactions to asset price and lending booms are feasible.

But the Fed should relinquish its role in day-to-day supervision and regulation of financial institutions (approving mergers, enforcing and making various financial rules, and acting as a prudential supervisor). In fact, maintaining that role threatens Fed effectiveness and independence in countercyclical monetary policy and in macro prudential regulation. The U.S. is virtually alone among developed countries in mixing the role of monetary policy and day-to-day financial supervision and regulation, as other countries have recognized the advantages of separating the two to avoid the politicization of monetary policy. It is high time the U.S. followed suit.

Unfortunately, the Obama Administration's new financial reform proposals combine some good ideas about enhancing the Fed's role as a macro prudential regulator with very bad ideas that would maintain and extend the Fed's role in day-to-day supervision and regulation. In part, Washington's tin ear about the desirability of limiting the Fed's role reflects the desire of many in Congress and the Administration to further politicize the Fed, a trend that has been gathering force over the last three decades and has now reached an all-time high.

Somebody with far more fiscal knowledge than I can claim has to answer this. So I won't. But, just for fun, wouldn't it be great to have a debate between two Democratic icons? Andrew Jackson on the evils of a national bank and Woodrow Wilson on the glories of the Federal Reserve. Even the impressive resources of POLITICO can't manage that. It's too bad.

"Of course the Fed is too powerful. So what? Because so is Congress..."

To argue that the Fed has only conducted business in the area of monetary policy is to misread the Fed's considerable history in regulation. To argue that bankers know more about risk than regulators...I can't stop laughing hard enough to type the rest of that sentence. Of course the Fed is too powerful. So what? Because so is Congress and the ability of its members to conduct oversight. If the members would actually do that with more credibility. As entities, both the Fed and Congress misjudged the housing bubble--and left the American economy to fly over a cliff--until they corrected it by a hair with TARP. An expensive misjudgment, for sure. And we won't be sure for a decade or more just how expensive.

What did voters do? Reelected most incumbents, naturally. And punished the Republican party as well.

The plus side of the expanded Fed powers is that it has now conceived of the means to regulate what it failed to regulate before--a bit like preparing to fight the last war, but better than what was existed previously in regulating the shadow economy. Which was nothing. The down side is the Fed is now in charge of regulating a portion of the financial industry, and it has never shown much of an independent streak when it comes to monitoring that sector of the economy. And: the policy to rein in corporate executive incomes is futile already.

So the Fed may have been given expanded powers--but it may show little inclination to use it. That would be a major failure as well.

The financial regulatory system needs a major overhaul, and Obama's basic approach is consistent with the investment and banking changes that have occurred in the past 20 years, but let's resist the temptation to politicize the Fed no matter how much we blame it for the current crisis.

I understand what the President is trying to accomplish here: the financial world itself has changed dramatically over the past 20 years, blurring of lines between banking and investment. Both the Clinton and Bush administrations sought to adapt to those changes by removing artificial barriers between the two (so let's stop this nonsense about financial markets deregulation being a Bush phenomenon), but both failed to update the regulatory structure in anticipation of the risks associated with unrestrained securitization, just as Barney Frank and his fellow Democrats turned a blind eye to the consequences of over-leveraged securitization in the housing market. By the time they all caught on to what was happening, including expansion of the Fed's powers proposed by Bush in March of 2008, it was too late to stop the damage.

Some inside the Obama administration think these changes should lead naturally to a single "super-regulator" that watches over financial markets, banking, consumer credit and the economy, but that's just plain scary to consider: an economic czar of czars. It smacks too much of the leftist hubris that the says economy can be and should be "managed" by the federal government. Instead, that, I'd favor the basic "coordination" approach that underlies the plan that Obama finally proposed: separate regulators of different-but-interrelated market segments are coordinated by joint committee and information exchange. Where I disagree with the plan is on the allocation of powers among the agencies involved.

The financial regulatory system needs a serious update because the distinction between securities and loans is nearly gone and financial risk has become increasingly systemic, both globally and among different types of securities, but the Fed should be only a minor part of the change. In my view, the Fed should be a giant smoke alarm warning of systemic risk but empowered only via monetary policy, not the direct institutional regulatory controls envisioned by the Obama proposal. As I noted in my Wednesday post, I have a concern with making the Fed into a day-to-day regulator, one area where Obama goes well beyond Bush's regulatory reform vision of March 2008. Meanwhile, the Securities and Exchange Commission needs expanded powers and budget to enforce transparency and to map the layers of risk in derivative financial instruments. Treasury needs to become a type of anti-trust watchdog on institutions that engage in risky and oligopolistic behavior, avoiding the "too big to fail" problem at its root. The SEC and Treasury, not the Fed, needs to be the regulator of holding companies and large financial institutions. And all need to work together, albeit not under a single authority other than the President, perhaps via the Secretary of Treasury. I'll leave Obama's proposed consumer finance regulatory agency for another post.

Endowing the Fed with new regulatory powers and consequent Congressional oversight would actually threaten the independence I value in the Fed. Even as pundits from both sides of the political spectrum gripe that the Fed did a poor job of managing monetary policy over the past decade, I'm more concerned about protecting monetary policy from their counterparts in Congress and the White House. We've already seen what happens when they get their hands on a car company: an inefficient plant stays open in a key Congressional district and a win-win parts sourcing deal gets killed at a favored union's behest. Just imagine what might happen to the money supply in anticipation of the 2012 presidential election.

Effective regulation requires an agency that is sufficiently independent of both the companies that it regulates and the political process. The Federal Reserve has the needed degree of independence. It also carries the stature necessary for a governmental body that at times will have to make difficult and controversial choices for the country. A less respected institution will not have the political capital required for such decisions.

While the expanded powers may belong at the Federal Reserve, it is important to rethink the way policy is made at the Fed. As illustrated by the Alan Greenspan era, a single person can assume too much authority and responsibility for determining economic policy. We may need limits on the length of time someone can serve as Fed Chair (Greenspan served for nearly two decades), or we may need to modify the governance structure, but change at the Fed should be part of the reform.

Allan MeltzerProfessor of Political Economy and Public Policy, Carnegie Mellon :

The Obama program is wrongly directed. Who knows more about the risks on the balance sheet, the banker or the regulator? The banker, of course. The proposed system continues a system that allows bankers to receive profits and the taxpayers to bear the losses.

A well-designed program would eliminate the Fed's use of too-big-to-fail, thereby returning responsibility to the banker for controlling risk and bearing losses. That system worked well in Britain for 100 years earlier in financial history.

Who knows what is "systemic risk"? The systemic risk regulation would bring Fannie Mae and Freddy Mac writ large. Every Congressman would urge that the bank or firm in their district should not fail.
Legislation will not define "systemic risk" usefully if at all.

We should go the other way. Bring back banker responsibility for mistakes, eliminate Fannie and Freddie, and put ALL government credit programs on the budget.

The President is expected to sign a War Supplemental bill today that included a “Cash for Clunkers” provision. This program spends $1 billion (Obama pocket change) to offer consumers up to $4,500 of incentives to purchase a more fuel-efficient car. Aside from this being yet another auto bailout disguised as a public service, this program directly impacts the poor, unemployed, veterans and the charities that serve them. Charities collect cars every year to help returning vets or families who may need to drive to and from a children’s hospital, or new job. Some Americans depend on this generosity. This program eliminates the ability for a charity to collect cars, since $4,500 is much more appealing than a small tax deduction.

And because the program is designed to get these old cars off the road; once they are turned in, they are destroyed. In other words, buying a used car just got a whole lot more expensive. With less used cars available, the remaining cars will clearly go up in price. But used car dealers aren’t counting the money yet, because the program doesn’t offer the incentives for buying used cars, only new ones. So that struggling family who was driving the gas guzzler has to take on an expensive new car payment if they want the government handout. And to all the environmentalists: how much energy is consumed by destroying and building a new car versus owning one that gets less than favorable gas mileage? In an effort to create their ideal centralized world, Nancy Pelosi and Barack Obama have spent another billion dollars on a program designed to hurt the poor, unemployed and charitable. Another great day for America.

Nolan McCartyProfessor Politics and Public Affairs, Wilson School of Public and Intl. Affairs :

The Fed is one of least accountable parts of the U.S. government

Given its governing structure, especially the long terms for the Governors, the Fed is one of least accountable parts of the U.S. government. So any increase in its authority must be considered warily. I am especially concerned that the Fed is to be given a very large degree of discretion in defining the Tier 1 financial holding companies that it is now to regulate. As the administration's plan indicates, the definition will not be limited to financial conglomerates that have bank or bank-like subsidiaries. Nor will it be based in any direct way way on the size or structure of the firm. That the Fed may be able to simply pick and choose which firms it will regulate opens tremendous opportunities for politicization.

But my bigger concern is whether the Fed's new authority will be compatible with its traditional role in setting monetary policy. There are likely to be times when its responsibilities for regulating financial holding companies will conflict with its macroeconomic responsibilities. If we were worried before that monetary policy was captured by Wall Street, the problem will become magnitudes greater.

In a 2006 interview, Nobel economist Milton Friedman said that a computer program could run monetary policy better than the Federal Reserve

He went on to observe: “That raises a question about the desirability of our present monetary system. It is one in which a group of unelected people have enormous power, power which can lead to a great depression or which can lead to a great inflation. Is it wise to have that power in those hands?”

The president’s new financial regulatory plan would give even more power to these “unelected people” at the Fed. Under the plan, the Fed have vast new powers to supervise large financial institutions and holding companies considered too big to fail, and to regulate new areas of the financial markets.

More often than not in our history, the Federal Reserve has been the root cause of financial bubbles and economic busts. Most economists believe that the Fed was largely responsible for the recent housing bubble and the resulting economic carnage because it kept interest rates too low for too long. Given this track record, to grant the Fed even more power over our nation's financial sector seems unwise, to say the least.

Milton Friedman had a better idea: “An alternative would be to eliminate the Federal Reserve System; to reduce the monetary activities of the federal government to the provision of high-powered money, that is, currency and bank reserves, and to constitutionalize, as it were, what is to be done with high-powered money. My preference is simply to hold it constant and let financial developments produce the growth in the quantity of money in the form of bank deposits, a process that has been going on for many decades.”

The Federal Reserve was the principal cause of the financial crisis, so it's an odd solution to give it more power

The Fed's artificially low interest rates created cheap money and easy credit that sent the wrong signals to investors, who made lots of unsustainable investments. Meanwhile, it wasn't a lack of regulation that caused the crisis. Regulators pushed lenders to make "affordable," no-down-payment, and subprime loans. And there's no evidence that Congress and the regulators have learned to stop distorting the decisions of investors and businesses.

During the crisis last fall the Fed assumed unprecedented powers, with little oversight from Congress. The Fed chairman worked hand in glove with the Bush administration. It's troubling enough to have an unaccountable body in charge of our money supply, and in fact its record on inflation and on continuous boom-bust cycles is dismal. (Better than most other central banks, but still dismal.) But at least the independence of the Fed gave us some protection from politicians' constant desire to pump up the economy before elections. If the Fed assumes more regulatory power, and works closely with the political authorities, how can it retain its independence? It will become another player in the morass of politics and lobbying that characterizes most of Washington.

We can count on the Fed creating more cheap money to get us out of this crisis -- indeed, it's already doing it -- and to "stimulate" the economy in the future. As the money-creation side of the Fed pumps out money, will the regulatory side tell banks and other businesses "ignore the interest-rate signals from the other side of the building! Lend prudently! Don't believe what the cost of money is telling you!"? That's a prospect only Washington could come up with.

By the way, the FDIC reported recently that total government financial assistance to firms in the current crisis now exceeds $13.9 trillion (almost exactly annual GDP). How will that ever be paid for, other than by monetization and resulting inflation? And why is it that in Googling for the details, I find the FDIC's report on financial sites, at Reason magazine, and at the Economic Times of India, but apparently not even mentioned at major American newspapers?

What I am more concerned about is the political intrusion by the Obama Administration over a independent agency

The Fed already has great power. What I am more concerned about is the political intrusion by the Obama Administration over a independent agency. The Feds powers should not be expanded and the White House and Treasury should not seek to control it. The Fed should answer to Congressional oversight.

The problem with the Federal Reserve is the mismatch between its mission and capacity

Historically, the Federal Reserve has been responsible for managing macro-economic policy and has developed a staff with expertise in that area. In the current situation, though, the organization’s mission has grown to include financial regulation and oversight of major companies. Unless the Fed is able to build its capacity in these new areas, the risk of policy mistakes is quite high. When agencies take on missions for which they are not prepared, they often make serious mistakes. Congress has the choice either of scaling back the mission or increasing the capacity. It must do one of these to avoid big problems in the future.

The idea that the Fed will be getting some enormous increase in power by the Obama plan is absurd

The Fed has always acted as the systemic risk regulator. It never restricted itself narrowly to the conduct of monetary policy.

In 1987, when the stock market was crashing, Greenspan took it upon himself to ensure that the primary dealers had access to the credit needed to keep the market open. This was an issue of systemic risk, not monetary policy.

The same applied to his intervention in the unwinding of the Long-Term Capital Hedge Fund in 1998. It is very hard to describe that as monetary policy.

In both these cases, the Fed intervened in areas that had no direct relationship to monetary policy because it perceived serious financial risks. The story of the current crisis is not that we lacked a systemic risk regulator, but rather that our regulator failed dismally at its job.

Specifically, the Fed allowed an $8 trillion housing bubble to grow unchecked. This was a policy that was guaranteed to produce a disaster of the sort that we are now seeing.

The real problem of the Obama proposal is that it lets the regulators off the hook. It implies that the problem was the regulations, not the performance of the regulators. This is a very important issue because at the end of the day, even the best set of regulations will only be as good as the people who enforce them.

If you can completely fail in your job, as was the case with the Fed in allowing the bubble to grow unchecked, and suffer no consequence, then the message for regulators in the future will be to just go along. Regulators are first and foremost concerned about their careers. They know that they will take big risks if they try to rein in powerful financial institutions.

On the other hand, if just letting them do what they want carries no consequence, even when it leads to disaster, as is the case now, then regulators will always be inclined to just defer to the financial industry. If we want good regulation, the most important thing to do is to hold people accountable. We should fire Ben Bernanke and many other people at the Fed.

Joseph Goetz (guest)
Retired , OH:

Sirs, In response to the question "is the FED getting too much power" it may be necessary to know exactly who you mean by the FED. Do you mean the Federal Reserve Bank? If so, I don't remember voting to give them any power at all. They are just a banking system. Besides that, aren't they right in the middle of all the problem in the first place? Please remember that I am just a 70 year old guy that remembers the way things used to be. I have no political axes to grind or no monetary gain to make from anything I may suggest or propose. Now then, why the heck do we really need the FED?

Lee (MMBJack) McCarty (guest)
Research Energy and Gaming , NV:

The status and reality of the Federal Reserve as an independent arm of the Government is a good one. In the hands of an Administration such as we had under Cheney-Bush - along with everything else they did to undermine effective regulation - they actually subverted it. So the Fed floated into floods and currents beyond their control in the lead-up to the greatest plunge in the fortunes and prospects for Americans ever witnessed since the Great Depression. Had others so-called regulating the Banking and Financial Sectors done their job honestly then an honest Fed might have helped, but acting alone they were not able to prevent what happened to our economy under the Republicans. The economy handed to this Administration following the election was virtually irreparable, and now those Republicans in this past Congress and Administration are scrambling for ways to say "this is all Obama's fault now that he is the one in charge of this economy". Now the Fed is under new status as an honest regulator and balance wheel for our economy. Elections have favorable consequences that include fixing the problems that led us into the ditch. Maybe it has tilted too far in the direction of not using punishment but rather has created incentives - and if not a perfect fix it is none-the-less the best over-all answer that smart and principled people can do.

Carl Owen (guest)
Mailman , OK:

Will the Federal Reserve get too much power? Are they the least accountable of all government agencies? Who cares. The Fed didn't get us into this economic mess unless you feel it's their fault for not minding the store better. Who voted for the CEO of Bear Stearns or BOA or Goldman Sachs? Not me and yet these people have the power to complete decimate my, and a lot of other peoples,world. Their greed/incompetence/indifference nearly melted down our country yet we're wringing our hands over whether we're over-regulating them. Absolutely unbelievable! If these Masters of the Universe were up to the task of responsible financial leadership we wouldn't be having this conversation. So let them sulk back to the Hamptons and pout. I'm not worried about over-regulation, I'm worry about effective regulation.

Patrick Northway (guest)
Acct/Finance , IN:

Allan Meltzer, Professor of Political Economy and Public Policy, Carnegie Mellon: The Obama program is wrongly directed. Who knows more about the risks on the balance sheet, the banker or the regulator? The banker, of course. This is the problem. "The banker, of course." Particularly when the Banker took those risks with no knowledge or rational reason whatsoever. Too much power? That is not necessarily the correct question. There is FAR TOO LITTLE transparency in the "private" sector-across the board. When financial companies become "too big to fail", they become too important to leave to the judgment of self-interested parties who benefit from non-disclosure. By whatever means, organization, or party, there must be absolute, across the board, transparency and access to any and ALL financial information. The private sector has destroyed any notion of trust, accountability, or responsibility.

anthony Noel (guest)
business columnist :

Yesterday I agreed with Cesar Conda for the first time ever - and what I was confident would be the last. How wrong I was! Mr. Conda and others here who fear The Fed's suitability for this particular mission, and its capabilities in general, are absolutely right. I even agree with the Milton Friedman quote Mr. Conda cites, right up to the point that it departs the tracks with that nonsense about "let[ting] financial developments produce the growth in the quantity of money in the form of bank deposits, a process that has been going on for many decades.” This sounds great, but is ipso facto untrue, because financial developments will never happen in the vacuum that Mr. Friedman's model would require. Governments will always collect taxes, employees will always want more, and yes, the captains of industry will always be greedy. Regulation is clearly needed; at issue is the form it should take and how to manage it. I'd favor pretty much anything over the combination of eggheads and incestuous former bankers/political appointees (read: foxes) who now "run things" (read: "guard the chicken coop"). Maybe Friedman's suggestion of computerized control of monetary policy has real merit! Yeah... a computer-based system that sends to the keyboards of predatory lenders and other financial industry lowlifes a lethal charge of electricity the moment their misdeeds are uncovered. Now THAT would keep 'em on their best behavior. Well, most of them. Mmmmaybe.

Adam Supernant (guest)
Admin Assistant , MD:

More power to the Fed! The Fed, for all it's faults, is really a great concept. Independence from partisan control is a huge factor, but what I appreciate is the melding of professionals from the financial industry working directly with career civil servants. This public-private blend is very conducive to our highly capitalist system.
If regulation is going to increase, it would be much better to have an independent agency hold the reins. I'd rather have the Fed than the Treasury Dept manage this program, and running it in an existing agency reduces an expansion of bureaucracy.

Phil Gonzalez (guest)
retired , TX:

Failure is not an option. What happened to we feel your pain. President Obama finally found a way to bypass the Congress. He's doing it by giving the Federal Reserve powers in which they won't be held accountable to anyone. Not even Barney Frank. If all banks are subject to audits, why isn't the Federal Reserve. If the Federal Reserve is going to be given additional powers, then they should be as transparency with providing information concerning which banks get bailout monies and which businesses are granted different regulations because they are too big to fail. The stimulus is a perfect example of squandering monies and now the Federal Reserve is going to be given a green light to squander monies away with no oversight by Congress. Should anyone be surprised. President Obama has appointed Czars with the same powers and they are answerable only to him. No Congress and no Senate. Another way to bypass Congress. This seems to be a pattern of President Obama. To bypass when he wants fast track passage with no debates and votes. What better way to do it. Just appoint more Czars and give additional powers to institutions who will carry out his wishes. After the Federal Reserve are given these additional powers, which businesses are then free to operate without the Federal Reserve coming in and saying we want to expand and we want you to buy out other businesses which are deemed to fail. Is that the way the businesses want to be regulated. With a strong arm and no choices. Does Bank of America and Chrysler ring a bell.

Karl Knapstein (guest)
Service Tech , CO:

Getting? I am pretty sure Monetary policy at the Federal Reserve is at the root of all the misfortune that as befallen us for the last 90 years. Every recession, our low wages and all the De/Inflation spirals. Why? I think it is to keep us down and beholden to the the "Company store" When a rumor went around after 9/11 that bad credit could put one one the "no fly" list, I gained a new level in my concern for our personal freedoms. "Control Inflation" is really code for Low Wages afterall and when hard working Americans constantly find ourselves playing catch up, the system is skewed towards the mogul class. Henry Ford knew the worker needed to afford his products for his Company to be successful. We need to thrive, not just exist for the well being of the wealthy.

Stefan Saal (guest)
sculptor , NH:

"Evils must be openly discredited. Nor should our own shortcomings be glossed over." If the Fed enforces prudential capital reserve requirements based on a bank's total assets-- say 18% for the biggest banks, sliding to 9% for the smallest banks --that would be a good use of power. Furthermore, if as part of this reserve requirement, the Fed forces bankers to retain a significant portion of the products they offer-- say 12% across the board --that would reduce incentives for the "get rich quick" swindles that the Fed has been permitting. Transparent rules will naturally re-size risks to scales that pose less danger to the banking system, while holding participants to account.

Jonathan Wolfman (guest)
Writer/Editor , MD:

A problem with any plan is that we already know that both the Fed and the Congress have failed us and little in the new proposals suggest that it holds individuals to account. Because it keys on the idea of tighter regulation in order that we may better see and control what's coming, not to let the bad signs to go unseen yet again (necessary, of course), but not on the actions of people at the Fed who in the recent past seemed to walk blindly through financial mine fields and not on the behaviors of future regulators, the new proposals may not be as effective as we need them to be. Congress, too, doesn't seem fully up to the task--during the automobile corporation hearings, for instance, and in other finance-related ones, few in Congress (in their questions to leaders in the private sector) seemed adequately to grasp more than the most basic market ideas nor, more importantly, the overall fiscal policies that attach to any particular sector's (and the nation's) well-being. We need to safeguard against systemic collapse and not just the failure of an industry or of a few industries. It is unclear right now if there are enough people in Congress who know how to work with the Fed on this in detail and it's equally unclear that the Fed or Congress is willing to get rid of the people at the Fed who helped bring us this most recent disaster.

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